The Alternative to Austerity

by Tim Bending

Responding to recent discussion on New Left Project, Tim Bending argues that the much-needed opposition to massive cuts must be supported by an alternative approach to promoting economic recovery. Such an alternative can be found in the politics of redistribution.

The alternative to cuts is not just more borrowing. It is redistribution and the creation of a more equal society. This is not just good in itself; it provides a stimulus to consumer demand, and is rapidly becoming the last realistic option for securing an economic recovery. This article sets out the economic case for redistribution.

A few weeks ago on New Left Project, Kevin Blowe wrote on the need for a clearly articulated opposition to massive cuts: an Alternative Plan for the Economic Crisis. From contributions on this site and elsewhere, we can start to see what such a plan might look like: a preference for taxing the rich over cuts for the poor; a preference for investment in what’s socially useful and for cuts to waste like Trident. Lots of good ideas. But perhaps we’re skirting around the main issue: How can we promote economic recovery? How can we create jobs? How can we manage the massive private debt hangover from the last decades? And how can we hope, eventually, to get the public borrowing back to a sustainable level?

Mainstream economics only seems to be offering four unpalatable ways forward:

• Try to balance the budget through cuts and/or tax rises, and hope, risking the creation of a downward, recessionary, deflationary spiral (neo-classical/Thatcherite).

• Keep borrowing and hope that growth (that is not dependent on continued stimulus) somehow returns before the bond markets pull the plug (orthodox Keynesian).

• Partial or complete sovereign default (risking blow back if the financial system collapses), and hope.

The great hope seems to be export-led growth, but as has been noted, its not clear who will do all the importing. What we need is not so much an alternative, as a solution.

The key to recovery is to maintain and stimulate aggregate demand, as Keynesians advocate. The problem is that the mainstream Keynesian remedy of deficit spending is only sustainable if there is a prompt economic rebound. As described below, this doesn’t appear to be the context we are in. Many countries in Europe are already at the buffers.

This is why the left needs to turn to a largely over-looked observation of Keynes (though hinted at on this site by Susan Pashkoff), that tax-based public expenditure in itself stimulates demand, and that “If fiscal policy is used as a deliberate instrument for the more equal distribution of incomes, its effect in increasing the propensity to consume is, of course, all the greater.” (General Theory, Chapter 8, II). In other words: redistribution can be used to create a stimulus effect, promoting job creation and recovery, without a necessary need for fiscal expansion, merely by allocating existing resources in a different way.

We need to understand why this is the case. The explanation also sheds a revealing light on the origins of the current crisis.

The explanation of persistent unemployment

Keynes’ starting point was the behaviour of individuals regarding consumption and saving. How much of our income we save is determined by how much income we have (obviously), and our underlying desire for savings relative to consumption. The latter is influenced by a whole host of factors, including interest rates, expectations of future need, expectation of the utility of further consumption, and cultural values.

Keynes observed that as people become richer, they tend to save a greater proportion of their incomes. This is largely because, with increasing wealth, the utility of further consumption falls. The same is true on a national scale: falling unemployment means increasing average household income, creating a tendency for the overall rate of saving to rise.

This seemingly innocuous fact has far-reaching implications. A rise in employment means, on the one hand, an increase in the production of goods and services. On the other, it means a rise in income and consumer demand, but because of the tendency for the savings rate to rise at the same time, consumer demand doesn’t rise so fast as production. It starts to lag behind supply. The market can respond to such an imbalance in several ways:

• Increased domestic investment by firms could absorb the increased production and savings. Unfortunately, investment beyond the rate needed to sustain consumption is unsustainable (unprofitable) over the long run. Such over-investment will lead to a compensatory period of under-investment. This is the classic business cycle.

• Speculation on asset prices (houses, shares) could absorb increased savings and return them to circulation, maintaining consumption. Obviously, this is also unsustainable (a bubble), effectively borrowing demand from the future.

• Increased consumer credit could absorb savings and maintain consumption. This is linked to asset price speculation (houses) and is similarly unsustainable. Demand is effectively borrowed from the future.

• Firms will react to increasing inventories of unsold goods by cutting back production and employment, reducing income and causing the rate of saving to return to its previous level.

In other words, over the longer term, the hidden hand of the market will balance aggregate supply and demand by maintaining enough unemployment to ensure that people don’t save too much of their incomes. In the shorter-term, however, various types of bubble may trick us into thinking that sustainable employment growth has taken place.

Keynesianism and capitalism’s “Golden-Age”

The 1950s and ‘60s are seen as the “Golden Age” of capitalism. A conjunction of factors sustained low desire for savings compatible with a sustainable rate of saving at a high level of employment. These factors included a build-up of private savings after the war years and the Depression, pent-up demand for goods like suburban housing, cars and domestic appliances, and welfare state policies and organised labour that enhanced financial security and reduced inequalities (see The Great Financial Crisis).

In this favourable context, it was not difficult to achieve something like full-employment, and the problem of the day was seen as countering the business cycle, making sure that any down-turn was shallow and none turned into a depression. Orthodox Keynesianism thus used public deficits and surpluses to counter fluctuations in private investment spending and to maintain aggregate demand. For a while, it worked.

The limits of Keynesianism

Since the war, industrialised economies have become richer, and also older, increasingly concerned with saving for old age. Latterly, neo-liberalism has made the situation worse, increasing inequality and dismantling the safety nets of the welfare state, again encouraging saving. The level of employment compatible with sustainable saving, borrowing and investment behaviour has fallen. This process began in the late ‘60s.

Orthodox Keynesianism was fine as anti-cyclical policy, but it couldn’t sustain employment in the face of such a long-term trend. As the ‘60s came to an end, maintaining previous levels of employment started to require ever greater fiscal and monetary stimulus, with ever less opportunity to re-balance the books. It was unsustainable.

Privatised Keynesianism – 1979–2008

Led by the “Anglo-Saxon” economies, the ‘80s and ‘90s saw a turn to what Colin Crouch has labelled “privatised Keynesianism”. In other words: more of the same, only with public borrowing replaced by private borrowing and speculation as the engine of unsustainable demand management. In the US, total outstanding debt rose from 154% of GDP in 1970, to 373% ($53 trillion) in Q1 2009 (see here, table L1, and here, table B-1). This trend has been accompanied by the rise of the FIRE sector (Finance, Insurance and Real Estate). In the 1960s, it accounted for 15% of US domestic corporate profits; the 2000-2008 average was 35%, peaking at 43.8% (see here, table B-91). It is common to blame the growth of ponzi finance on de-regulation, as if without de-regulation everything would have been just fine. But there was an underlying problem of stagnation and the growth and “innovation” of finance, helped along by neoliberal de-regulation, seemed to offer a solution.

Indeed, these trends succeeded in propping-up consumer demand and employment, even creating consumer(-debt)-led booms in the US, UK and elsewhere, absorbing the savings and exports of the more saving-prone Japan and Germany. But these trends were never sustainable, prompting a series of worsening crises from “Savings and Loans” to “Dot.com” and “Subprime”. In each case governments and central banks have rescued the financial system, acting as the lender of last resort, but their capacity for further bail-outs is reaching its limit.

The alternative to austerity

Since 2007, governments have returned to “public Keynesianism”. Deficit spending has been the right thing to do, but in the absence of a strong growth rebound, its rapidly becoming unsustainable. With bond markets threatening to veto the refinancing of debt, governments are now turning from stimulus to the depressant of fiscal tightening.

Yet this short history points to the alternative approach described at the beginning of this article. The redistribution of income puts more money in the hands of those who tend to consume a high proportion of their incomes (the poor), and less in the hands of the wealthy who tend to save more of what they get. Technically speaking, it raises the level of employment compatible with a sustainable rate of saving. In more familiar language, it provides an economic stimulus, increasing demand, in a way that does not rely on borrowing or printing more money, but merely reallocates existing resources in a different way.

All this should be obvious. For years, demand, and thus growth, has been propped-up by huge transfers of income from the well-off to the less well-off in the form of loans. Now the problem is that the less well-off are “maxed-out”; this particular form of stimulus cannot be continued, and even threatens to be put into reverse as the well-off demand their money back. The putative solution of the austerity agenda is effectively to force the less-well off to pay their bills: taxpayers’ money is used to bail-out predominantly wealthy savers, whilst the less well-off foot the bill through public service cuts. Obviously this is no solution at all to the core economic problem. The alternative to austerity is a similar redistribution of wealth, providing a similar economic stimulus. The difference is that the money wouldn’t have to be paid back.

Elements of an alternative plan

An alternative plan will need to cover three areas: we need a plan for crisis management to protect savings, pensions and banking services for the real economy; we need a plan for the radical reform of the financial system, both nationally an as part of an international effort, with the aim of freeing democratic states from the consequences of the irrational group behaviour of speculators, and we need a plan for reducing economic inequality.

What the latter may mean in practical terms is not difficult to surmise. The overall fiscal stance should be to maintain or increase public spending as a % of GDP, to use deficit spending as a positive stimulus tool, as far as is possible, and to reduce the deficit, if needed, principally through taxation, cutting only in the areas with least stimulus effect such as defence. Taxation needs to be made more progressive, including effective action against loopholes and evasion. New public investment (Green New Deal?) should focus on areas that create many jobs, such as home energy efficiency improvements. Finally, we need an industrial policy that aims to reduce pay inequality, through minimum, and perhaps maximum, earnings legislation, and a more conducive environment for workplace organisation and collective bargaining.

Tim Bending is a development consultant and writer on economic issues.

9 Comments on "The Alternative to Austerity"

david seddon, on 12 June 2010 - 16:01

Tim refers to ‘the Green New Deal’ and might have drawn more openly on the ideas set out by the Green Party in its various statements on ‘the Green New Deal’ as a more radical and progressive road to recovery than anything else currently on offer. It is to be hoped that an alliance of ‘red and green’ can develop around commonly held radical, progresssive ideas to promote a different economic and social strategy for sustainable development - this is clearly not just an intellectual and ideological project but a broader political project as well.

I am not sure that the ‘new left’ labour is particularly attractive - given the chequered history of the last ‘new left’ - I would prefer to see a genuine ‘progressive alliance’ drawing on the support that might be forthcoming from Greens, elements of the Labour Party, possibly even from disaffected social democrats from the Lib-Dems, ‘revolutionaries’ from the SWP, renegades from Respect, etc.

Owen, on 13 June 2010 - 23:47

Whilst I don’t disagree with your conclusions at all your argument doesn’t seem to address the fact that since ‘71 the UK has been sovereign in its own currency, which is really significant to what ‘sustainability’ actually means.

The UK government, like most (excepting the Eurozone), is not like a household or business in that it needs to fund its spending - it doesn’t ‘have’ (or lack) money as such. Spending occurs when it changes the balances of bank accounts. I think emphasising this is crucial to refuting the ideological push by neoliberals and the very wealthy towards cuts in public spending and accepting widespread unemployment as a fact of life.

It is entirely within the government’s power to provide for full employment and tax more progressively without endangering public services or pensions, and without the risk of inflation. If they really wanted they could simply buy back their ‘debt’, which itself is only issued voluntarily as an ideologically driven commitment.

I don’t know if you’ve come across him, but Bill Mitchell (among others) writes very lucidly about all this:

Tim Bending, on 14 June 2010 - 16:27

Dear Owen,

I’m familiar with the work of Bill Mitchell and his colleagues, and supportive of the post-keynesian school on many matters, but I don’t think this particular Modern Monetary Theory approach is quite realistic.

You see, they assert that a government only has to demand the payment of tax in its fiat currency to ensure the acceptance of the currency as a means of exchange and store of wealth. This isn’t the case; it is necessary that people have confidence that the currency (or assets denominated in that currency, like bonds) will not loose real value in the future. There are always alternatives for storing wealth: foreign currency, gold, stocks, real estate, and the situation is made worse by speculation (trying to predict the actions of other speculators). A policy based on net money creation risks triggering a flight to these alternatives, leading to a relative devaluation of the currency, triggering further flights, and so on.

On the other hand, a rising debt to GDP ratio increases the risk that a government will not be able to honour debts, in the event that savers/investors/speculators refuse to refinance them, except by creating money in a way likely to cause devaluation. As debt rises, confidence becomes increasingly fragile, and a collapse increasingly likely.

Thus the MMT guys are basically suggesting that governments with hard currencies soften them. The result would be quite like what happens in many soft currency states now. People put their savings in foreign hard currency, and the government cannot borrow in its own currency except at punitive interest rates. The worse case is hyperinflation in which people might invent alternatives currencies (many examples from 1920’s).

I think this is the reality faced by governments and I haven’t been able to find anything in MMT to really refute this. Of course, its a stupid and irrational situation that calls for drastic reform, but this article is really about how we could make the best of the current system to deal with the crisis, assuming still insufficient support for more radical systemic change.

all the best.

Charles Pearson, on 22 June 2010 - 13:18

A valuable article and interesting comments. As a socialist I am rather bothered that just about all of the ideas have to be classed as reformist, but at least Tim Bending in his response to Owen clearly states that this is “assuming still insufficient support for more radical systemic change” - which tragically is true at present. I think the last sentence of Tim’s article is of paramount importance, and would like to single out the tentative suggestion for legislation for maximum earnings. A big question is why should this be tentative? I have always found it to be annoying and frustrating that maximum earnings - and one should add assets for anything meaningful - is never considered . Of course the very idea would be anathema to capitalists and the millions who believe their propaganda, but concrete proposals for such maxima aren’t often made on the left either - though the Parecon movement is an exception.. I was interested to see a definite proposal for such legislation, “An Economy with Personal Asset and Income Limits”, in Scientists for Global responsibility Newsletter (winter 2010, issue 38) by Alan Cottey of the University of East Anglia(and see http://www.uea.ac.uk/~c013/ail/ail.html). I worked in Universities for nearly forty years, always under maximum salary conditions. The question is, if this is good enough for universities and in fact all public employees, why isnt it good enough for everyone, including bankers, CEOs and all the rest of the “top” people? I would hope that none of the NLP supporters accept the ridiculous fiction tha this is because these top people are the “wealth creators” and therefore entitled to their huge privileges. Naturally, there would be all sorts of arguments about how such limits should be determined. but a proper democracy should be able to come up with something reasonably fair - certainly much fairer than the present laws of the jungle.,

Very lucid article. It’s good to see the current recession thoughtfully analyzed from outside of the standard, capitalist framework.

While I share Mr. Pearson’s socialist leanings, I am less opposed to reformism. I come from a more radical background in the USA and spent several years feeling like I and my comrades were accomplishing nothing in the way of change. I’m in favor, now, of accomplishing the greatest good that is possible at any given time. If it only reform, that’s fine, so long as we push it to be the best, most socially just reform it can be and continue to push for newer, better reforms in the future. A constant pressure to push our governments and our nations’ people further toward democracy and socialism, I hope will allow for an eventual, peaceful revolution and the creation of a society that is finally built on the concepts of freedom, justice, and equality.

Charles Pearson, on 09 July 2010 - 13:25

I think WT and others who have commented are on what I call the True Left, but I think WT is ignoring many clear lessons from history in thinking reformism (i.e. gradualism ) will lead to anything that can be called revolutionary - peaceful or violent. You only have remember that gradualism has given us President Clinton and P.M. Blair. Terry Eagleton, with his usual humour, mentioned the reply an Englishman gave when someone said we should change to driving on the right side of the road instead of the left. “Yes”, he said, “but gradually”.

Tim Bending, on 09 July 2010 - 21:15

The Eagleton quote is great! But at the risk of setting in motion a fruitless debate about gradualism, can we at least agree that Clinton and blair were not gradualists, but paid-up neo-liberals who thought there was no alternative. They had no intention of gradually going anywhere. Or rather, they wore the clothes of gradualism in order to buy the support of the left with very small concessions and big false promises.

But I don’t think that means we can’t say, “We won’t be satisfied until we get A, and we won’t shut up about it, but we’ll support B in the meantime because its better than C.” The problem with New Labour was the calculation that to gain power we had to shut up about A in order to “become electable”. The labour left went along with it on the basis of the promises of gradualism, which then turned out to be false. Clearly the task at hand is not just top follow public opinion to gain “power” on someone elses terms, but to shift public opinion to the left. In the absence of dramatic events, that is likely to be a gradual process, and will allow progressively more leftwing polictical programmes to be implemented. Of course, eventually, dramatic events may be inevitable - here the analogy of changing the side of the road we drive on is apt.

This is a big issue in Europe where many left parties have to consider coalitions with centrist parties. I think left parties should always aim to be electable or a partner in government as long as the government programme is a step in the right direction, and as long as the right to keep on talking about the real alternative is a non-negotiable.

Tim Bending above suggests that money supply increases as advocated by Modern Monetary Theory lead to inflation.

Well the U.S. experienced an unprecedented and astronomic increase in its monetary base 18 months ago. Where’s the inflation? It’s near non-existent. Moreover, inflation can perfectly well arise for reasons that have nothing to do with money supply increases. For example the serious bout of inflation in the late 1970s and 80s is often attributed to the large oil price increase in the late 70s. (Not sure I totally agree with that theory, but never mind.)

Inflation only gets serious when aggregate demand exceeds the ability of an economy to meet that demand. As long as a money supply increase does not cause excessive demand, there will be no excessive inflation (as David Hume pointed out in his essay “Of Money” 250 years ago).